Commodities | Jul 26 2013
-Miners resilient despite soft demand growth
-Goldman sees least upside for copper, iron ore
-Refined zinc differs somewhat
-Headwinds for metals remain in place
By Eva Brocklehurst
There's been a lot of talk about the falling demand growth in commodity markets. What's happening on the supply side? The timing and scale of supply is key to price recovery. Goldman Sachs considers some commodities are thwarted in the path towards a more balanced market by the resilience of marginal producers in the face of operating losses and by the delivery of growth projects that were approved and financed some years ago. Moreover, mining companies are looking at productivity improvements to stay competitive and, together with the depreciation of some commodity currencies such as the Australian dollar, this can lead to lower marginal production costs.
As a result, there's further downgrades to price forecasts for a range of commodities under Goldman's coverage The most significant cuts over the forecasts out to 2017 are for coking coal (down 2-18%), thermal coal (down 8-13%), nickel (flat to down 13%) and platinum group metals (down 2-15%). Despite this the analysts suspect price risks are becoming skewed to the upside as the current cycle finds a bottom. The speed of the recovery will likely depend on how much prices have overshot on the downside, because the bigger the overshoot the more incentive to cut production and the less flexibility that marginal producers have.
Based on Goldman's 12-month forecasts, the commodities with the most upside relative to spot prices include lead, zinc, palladium and hard coking coal. Conversely, the least preferred commodities over that period are copper and iron ore.
JP Morgan has taken a look at the supply of refined zinc in China and has noticed that production growth, up 9.7% year-to-date, remains below growth rates for other metals and is significantly lower when looked at on a longer time frame. This relatively weak production growth profile follows a 6.1% drop in Chinese refined zinc output last year. The outcome is a 425,000t global deficit. Drivers of low production growth in zinc have been poor industry profitability, low prices, and a lack of new lower-cost capacity additions. This means zinc has not experienced the downward shift in costs which has bolstered production growth rates in other metals, such as aluminum and nickel, even as prices for these metals have also moved lower. JP Morgan thinks these developments are broadly positive for the global zinc market and suggest increasing net Chinese zinc imports over the medium term.
Before getting too excited about a zinc under supply, the analysts warn that high capacity continues to cap upside price appreciation potential, as smelters are still able to increase production and release inventory in the event of substantially higher prices. JP Morgan suspects that Chinese treatment charges will need to rise and cash prices will need to trade above RMB15,500/t (compared to the current price of RMB14,525/t) in order to provide sufficient incentive for domestic refined production to meet demand. Either that, or price rises need to drive a large enough premiums on Shanghai exchange prices versus LME prices to encourage increased refined imports from the international market, helping support LME prices.
What's the case for copper? Strong refined production growth rates suggest that received prices have been supportive of domestic producers with vertically integrated mining assets. This has allowed for continued expansion in primary smelting production, despite weakening prices. Another primary difference between zinc and copper is copper's secondary capacity additions have been significant. This is a production route that is not available in the zinc market, where recycling rates are low.
In nickel and aluminium, despite similar pressures on industry profitability the introduction of lower-cost capacity in China is enabling production expansion even as prices continue to fall and less-efficient capacity is cut. It adds up to the fact that the lack of a structural trend lower in refined zinc production costs can support prices going forward. JP Morgan estimates that Chinese zinc demand will grow by 7% this year to 6.1 million tonnes, driven by strong growth from the transportation and home appliance sectors. Headwinds and uncertainties remain in place. The global zinc refined balance is still tight and JP Morgan is forecasting a surplus in concentrate.
Meanwhile, Macquarie has made five observations from the Chinese customs trade data released last Monday. In copper, the strength in concentrate imports is notable. This is being driven by growth in global mine supply, and putting at risk the need for higher imports of cathode. In zinc, there has been a strong appetite for metal imports, driving a rebound in Chinese apparent consumption. In steel, traders appear to be exporting the surplus in both crude and stainless steels to the rest of the world. High Australian alumina prices appear to have driven away Chinese buyers and, lastly, a decline in nickel pig iron ore imports from Indonesia suggests high-cost nickel producers are cutting capacity.
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